Outcome Based Pricing
Pricing is a common topic of concern; both for the consumer and the supplier. Clients want a fixed price up front, in order to prevent a bait and switch environment where the cost far exceeds their budget. A reasonable concern to be sure. The challenge here is determining the cost or value of something before it is produced.
Three of the most popular pricing models are: Cost Based, Market Based, and Value Based. When we look at the alternatives, it quickly becomes clear that value based pricing should be the defacto pricing model for development, or any creative process.
Common Pricing Strategies
First we must recognize that development or a creative asset is a service-based product. Cost will most often be tied to employee and process costs.
For creatives, cost based pricing is a progress inhibitor. Using cost based pricing would require we never pay employees higher than a fixed amount. If employee cost increases, prices will increase or profitability suffers.
However, if we do not reward employees that increase their skills, we will forever be chasing new and less expensive talent. This employee turnover increases process cost, leaving us in a cost spiral that never ceases. Cost based pricing clearly will not work for a creative process.
Market based pricing is the most popular solution for creative work. The idea is that if everyone charges this, we will too. Companies are only able to remain profitable as long as they are competitive in the market place.
The major drawback and difficulty is that quality is not addressed here. The spectrum for quality is not only extremely broad, it also is highly subjective. Companies are often forced to produce lower cost and lower quality products in order to remain competitive. Conversely, companies who attempt to differentiate on quality struggle to demonstrate exactly how their work is better.
Value Based pricing in comparison, it is the most effective pricing model for someone like me, who focuses so heavily on quality, value, and innovation.
In this case I (the supplier) and the client (the consumer), both work in unison to help ensure the highest quality and the best value. Cost and value is determined after the item has been produced.
We both accept some of the risk, and work hard to make sure the inputs for processes determine the best outcome possible. We both focus on what is valuable to the client, which increases my profitability while stretching their budget farther.
Outcome Based Pricing in Action
An outcome based pricing model is unique and somewhat uncommon. Let’s explore exactly how this works.
We begin with a discussion of the project scope and budget. I create a range of estimates, one of which the client approves based on their budget. We then determine a phase-based billing cycle, typically tied to the phases or iterations of the Unified Process.
I then begin work on the project, keeping the client up to date on progress and estimated cost. At the end of each cycle, we review progress, and determine the value and the cost of what I have produced.
Only then do I submit my invoice, with the agreed upon cost, and payment is rendered. It’s simple, fair and effective.
A Process Flow Chart for Outcome Based Pricing
The Cone of uncertainty tells us: estimates created pre-production will be within ¼x and 4x of the actual cost. As we near completion of a project, the cone narrows, because we have better data to speculate from.
A far more effective strategy is to incrementally determine cost, and use that as a part of our feedback loop. This technique effectively removes the cone of uncertainty.